|
FEATURE |
Case Summary of Recent
Information Technology Decisions Relating to
IT Contracts and Outsourcing Arrangements
This article discusses the decisions and practical implications of four recent information technology cases from England relating to IT contracts and outsourcing arrangements.
_________________________________________________________________________________________________________________
Recent information technology decisions relating to IT contracts and outsourcing arrangements in particular have created waves in the technology law sphere. These recent cases have resulted in a palpable change in the manner vendors and customers conduct themselves. They have also precipitated necessary changes to the approach and key considerations lawyers have to consider in drafting legal provisions so as to avert specific legal risks as set out below.
The English High Court in BSkyB v EDS has found the defendants, HP Enterprise Services UK Limited (formerly Electronic Data Systems Limited) and Electronic Data Systems LLC (formerly Electronic Data Systems Corporation) (hereinafter collectively referred to as “EDS”), liable for making fraudulent misrepresentations to the claimants, British Sky Broadcasting Limited and its subsidiary, Sky Subscribers Services Limited (hereinafter collectively referred to as “BSkyB”) during the tendering process for the provision of a Customer Relationship Management (“CRM”) system.
In March 2000, BSkyB, provider of satellite broadcasting and related services, issued an invitation to tender for a CRM system for its business. EDS, a provider of Information Technology (“IT”) services, was eventually selected British Sky Broadcasting Limited and EDS subsequently signed a letter of intent on 9 August 2000. This was followed by the conclusion of the Systems Integration Contract (the “Prime Contract”) between Sky Subscribers Services Limited and EDS on 30 November 2000.
BSkyB’s intention was to introduce the new state of the art system as soon as possible. Hence, the project was to use a rapid application model of development where scoping, design, build and test were conducted in parallel as opposed to the traditional waterfall system where the development stages are in sequence.
However, the project soon went into difficulties. In March 2002, BSkyB and EDS signed a memorandum of understanding in which BSkyB took over EDS’s role as systems integrator in the project. Sky then commenced proceedings against EDS in August 2004, claiming about £700 million in damages.
BSkyB had a prima facie action against EDS for breach of contract. However, the Prime Contract contained a limitation clause that capped EDS’s liability at £30 million. To avoid being subject to the £30 million damages cap, BSkyB thus proceeded to claim against EDS for fraudulent misrepresentation (deceit).
In order to establish a cause of action in deceit, BSkyB had to prove that:
1. EDS made a false representation;
2. EDS knew it to be untrue or was reckless as to whether it was true;
3. EDS intended that the claimant should act in reliance on the representation; and
4. Sky relied on the representation to its detriment.
The basis of one of the five allegations of misrepresentation that BSkyB put forth concerned a pre-contractual letter from EDS to BSkyB that EDS had “the resources reserved for this project”. BSkyB alleged that this statement was a misrepresentation by EDS and that it had reserved and made available all the personnel required for the project.
However, the Court dismissed this contention as it was of the opinion that the phrase only meant that EDS had the global resources available from the EDS consortium members and organisations that it could use to deliver the CRM project. The Judge relied significantly on the expert evidence, which stated that there is a “cone of uncertainty” in IT projects where the effort or cost required would only become more certain as the project progresses along its development stages. As such, it is not possible for parties to identify and reserve all its resources at the beginning of a large and complex IT project.
The only allegation of misrepresentation by BSkyB which succeeded was the allegation of misrepresentation as to timing for completion of the project. BSkyB alleged that EDS had made misrepresentations as to the time for the delivery of the project prior to the letter of intent. Sky alleged that EDS had represented that it had carried out a proper analysis of the amount of time it would take to complete the project and also that it held the reasonable opinion that it could complete the project within the timeframe of nine months.
The Judge accepted that EDS had made the representations without belief in its truth as no proper exercise had been undertaken by EDS to establish an estimation of time required for the project. Furthermore, EDS knew that this was the case when it had made the representations to BSkyB.
This conclusion stemmed largely from evidence given by Joe Galloway, then Managing Director of EDS at the time of the bid and was found to be crucial in EDS’s responses to BSkyB. He was found to have given perjured evidence about his academic qualifications that destroyed his credibility. This alone did not prove that he had made dishonest representations but it did place a considerable evidential burden on EDS that it could not disprove.
The Court found that BSkyB had relied on the representations of time made by EDS as BSkyB had wanted to complete the project as soon as possible.
The Court found that BSkyB would have selected another vendor but for EDS’s deceit. Hence, the Court went into detailed analysis of how long the other vendor would have taken to implement its system for BSkyB and how much loss Sky had suffered as a result of not choosing the other vendor.
In June 2010, EDS agreed to pay a total of £318 million for damages, costs and interest related to the contract which includes a £270 million interim settlement payment that EDS had made in February 2010. HP Enterprise Services UK Limited which has acquired EDS following the commencement of the proceedings has issued a press statement that it will not be commenting further on this legacy issue now that the matter is now closed, having been settled fully and finally on mutually-agreed terms.
BSkyB v EDS has given shared services practitioners a contextual guide on how Courts will view parties’ behaviours in the tendering process. It indicates the importance of carefully managing the tendering and solution development process to avoid the risks involved in baseless promising.
It is recommended that parties be transparent when negotiating time and cost issues so as to ensure that both sides are on the same page at the beginning of the project. This would require a certain level of trust between parties but the benefits of such openness would be the prevention of unrealistic timelines that may lead to a subsequent failure of the entire project or relationship.
From a drafting perspective, BSkyB v EDS highlights the importance of incorporating non-reliance clauses and clauses that seek to exclude liability for pre-contractual representations.
GB Gas Holdings Ltd (“GB”), a subsidiary of Centrica Plc, had contracted with the defendants (hereinafter collectively referred to as “Accenture”) for the provision of an automated billing system for GB’s business. The contract contained warranties setting out the obligations of Accenture in the event of breach, including the obligation to fix the system in the event of a fundamental defect or fund the necessary remedial in the event of a material defect. GB subsequently experienced major problems with the system and requested Accenture to remedy the defects vide a letter. Accenture was of the view that there were no fundamental defects obligating it to take remedial actions. As a result, GB commenced legal action against Accenture for breach of contract and claimed damages under various heads.
In the preliminary hearing, the Court allowed various claims by GB as direct losses. The Court further held that Accenture’s individual breaches of warranty could constitute a fundamental breach of warranty and that the consequences of individual fundamental breaches of warranty alleged by GB can be aggregated for the purposes of determining whether there is a severe adverse effect on GB’s business.
In coming to this conclusion, the Judge held that the warranty clause must be construed with knowledge of the relevant background. In particular, he noted that it was Accenture’s responsibility to install a billing system that was free from errors and to do so without compromising the standards of service by GB. Furthermore, the parties must have known, amongst other facts, that (i) as the system was complex, an error in one process could affect another process; (ii) it was common to have defects in a billing system, which in combination created an aggregated defect; (iii) design errors in different processes could cumulatively impact on other processes; and (iv) the billing system was of critical importance to GB’s revenue and business.
The various heads of claim by GB include:
1. Excess charges that GB had to pay to its gas suppliers due to the inability of the billing system to indicate the precise amount of gas used by its customer;
2. Cost of compensation paid to customers for the inconvenience caused by the faulty billing system;
3. Cost of additional borrowing charges to deal with cash flow problems caused by the billing system;
4. Cost of wrongly chasing customer debts which were not actually due; and
5. Cost of additional stationery used in the increased correspondences with customers.
Accenture contended that it could rely on its exclusion clauses to exclude liability for loss of profits, contracts, business or revenues arising directly or indirectly and other loss, damages, costs or expenses to the extent that they are indirect or consequential. However, the Court held that the claims by GB were considered direct damages as in the first limb of Hadley v Baxendale. In coming to this conclusion, the Court placed great emphasis on the criticality and centrality of the billing system provided by Accenture to GB. The Court opined that the billing system was at the heart of GB’s business and that its revenues depend entirely on it operating efficiently. Hence, any breaches of warranty affecting the system would result in an adverse effect on GB’s revenues and thus GB was allowed to claim the above costs incurred as they flowed naturally and in the ordinary course of event as a result of the breach.
GB v Accenture overturns long held assumptions about the limits of direct and indirect damages. In particular, vendors of IT systems must take into account the centrality and criticality of the system when thinking about direct and indirect damages in the shared service context. This decision sheds light on the criticality and centrality of supported applications and services to a business and will have relevance to the question of whether losses and expenses due to vendor error or omission are direct, indirect or consequential losses.
GB v Accenture has shown that Courts are willing to find a more “advantageous” route to remedies if such an interpretation is not expressly precluded from the contract. Hence, parties could consider setting out specific expenses and claims as contractually agreed heads of direct damages. This decision is based on a preliminary hearing and a full hearing is expected to take place in early 2011.
Kingsway Hall Hotel Ltd (“Kingsway”), an inner London four-star hotel which needed a new IT system for its business as support for its existing system was being withdrawn was provided with a proposal for the “Entirety” system by Red Sky IT (Hounslow) Ltd (“Red Sky”), an IT company specialising in hotel booking systems. Red Sky made recommendations to Kingsway that the “Entirety” system was suitable for its needs and which Kingsway then relied upon in purchasing the “Entirety” system. Kingsway and Red Sky entered into a contract which contained Red Sky’s standard terms and conditions including exclusion of liability clauses. Red Sky failed to provide the operating manuals in order for Kingsway to make an informed decision about whether or not the system was suitable for its needs.
However, shortly after going live, Kingsway began to experience fundamental problems with the system. Red Sky made minor improvements to the system subsequently but these did not materially solve the fundamental complaints of Kingsway. Kingsway subsequently commenced legal action to recover damages from Red Sky for lost profits and loss of goodwill, the cost of a replacement system, additional staff costs and wasted staff costs. Red Sky then attempted to rely on the exclusion of liability clause in its standard terms and conditions to defeat the claim.
Red Sky’s standard terms and conditions are summarised as follows:
1. Clause 10.1 excluded all terms as to performance, quality, fitness for purpose etc except as provided in clause 10.2;
2. Clause 10.2 contained an express warranty that the programmes will in all material respects provide the facilities and functions set out in the operating documents;
3. Clause 10.4 provided that the sole remedy for breach of the warranty in clause 10.2 was the maintenance and support cover;
4. Clause 10.7 provided that clause 10, together with clause 18 stated the entire liability of Red Sky in respect of any fault or error in the IT system; and
5. Clause 18 contained limitations and exclusions of liability such as the exclusion of liability for any indirect or consequential loss. The term expressly excluded loss of profits and similar losses.
In Kingsway v Red Sky, the English High Court held that Red Sky was liable for failing to provide to Kingsway with an IT system that was fit for its purpose. The Court held that Red Sky was unable to rely on its exclusion of liability clause in its standard terms and conditions as it did not satisfy the test of reasonableness under England’s Unfair Contract Terms Act 1977 (“UCTA”).
The Court concluded this on the basis that the parties did not bargain on equal power. The Court opined that Red Sky’s standard terms were predicated on the fact that prospective clients would investigate and make up their own mind on whether or not the software would fulfil their needs based on demonstrations as well as the operating manuals provided by Red Sky. It did not apply to circumstances where the client relied on Red Sky’s advice in deciding to purchase the “Entirety” system. The Court was of the opinion that the representations in the operating manual would be crucial in explaining to potential customers whether the system provided the required level of sophistication and speed. Without the manuals, potential customers would not be able to make an informed decision as to whether the software fulfilled its needs. In this case, Red Sky did not supply to Kingsway the operating manuals before contracting and hence could not rely on its exclusion of liability clause in its standard terms.
Furthermore, the Court found the IT system supplied by Red Sky to be unfit for its purpose pursuant to s 14 of England’s Sales of Goods Act 1979 (“SOGA”). Under s 14 of SOGA, a term is to be implied into the contract that the “Entirety” system would be fit for the purpose for which it was bought, meaning that it would increase revenue and occupancy levels and would allow for quicker check-in and check-out, including accurately processing group reservations. From the fundamental complaints of Kingsway, the Court found the system to be unfit for its purpose.
Under s 4 of SOGA, a term was also to be implied into the contract that the goods were of satisfactory quality. The Court found that the “Entirety” system did not meet the standard that a reasonable person would regard as satisfactory. Hence, the court awarded Kingsway a total of £110,997.54 in damages.
Kingsway v Red Sky highlights the importance for suppliers of IT systems to give full and accurate information to potential buyers and to ensure that the terms and conditions of IT contracts satisfy the reasonableness test under UCTA.
Summary of facts of RTS v Müller
The English Supreme Court in RTS v Müller found that a contract existed between despite a “subject to contract” provision in their draft contract. The Court came to this conclusion by inferring from the parties’ correspondence and conduct, that they had waived the “subject to contract” provision. The terms of the contract were held to be the terms in their draft contract, as varied by a subsequent variation agreement.
Molkerei Alois Müller GmbH & Co KG (“Müller”) sent to RTS Flexible Systems Ltd (“RTS”), a Letter of Intent (“LOI”) as a confirmation of their intentions to proceed with a project with RTS. The LOI provided for RTS to begin work while the parties negotiated the final contract. RTS signed the LOI and began work for Müller on the basis of the LOI while the parties continued to negotiate the final contract, extending the initial duration of the LOI as they did so.
Müller sent a draft contract to RTS incorporating the standard terms and conditions published by the Institutes of Mechanical Engineers and Electrical Engineers, as amended by Müller (collectively referred to as the “conditions”). It contained terms on limitation of liability and liquidated damages as well as a counterparts clause which stated that no contract would come into existence until each party had executed and exchanged the counterparts.
RTS continued to build and deliver the equipment while Müller also continued to pay for the work done although the LOI had expired. The draft contract was never signed and a dispute arose between the parties.
The key issue was whether the parties had concluded a contract after the expiry of the LOI contract and, if so, on what terms.
The trial Judge had decided in first instance that the parties had reached a new contract on the expiry of the LOI. RTS’ appeal to the Court of Appeal reversed the lower Court’s judgment and ruled that the trial Judge had misinterpreted the counterparts clause and held that no contract was to exist until both parties had executed a written agreement.
The Supreme Court reversed the Court of Appeal’s decision and ruled that there was a binding contract after the expiry of the LOI. Further, the binding contract was held to have included the conditions. The Supreme Court came to this conclusion based on the inference from the parties’ correspondences and conduct. More specifically, the Supreme Court based the decision on the fact that the price had been agreed, substantial work had been carried out and also the parties’ agreement that a subsequent variation was not “subject to contract”. Therefore, the Supreme Court decided that the parties had waived the “subject to contract” provision and to rule otherwise would make no commercial sense.
The key takeaway from RTS v Müller is that parties should agree and finalise a contract first before starting work. However, if this is not possible and initial work is to be done, parties should ensure that this initial work is to be compartmentalised and captured in a separate agreement that is distinct from the main contract. For example, if a scoping exercise is to be carried out prior to the signing of the final contract, the terms of the scoping exercise should be put into a separate services agreement and signed by the parties. Parties should resist the temptation to enter into a broad LOI and for work to begin on that basis.
Parties must be mindful that their correspondences and conduct do not give the impression that work under the main contract has already commenced before the signing of the main contract. Work begun prior to the conclusion of the main contract should be encapsulated in a separate agreement distinct from the main contract.
Further, the commercial importance of a LOI is recognised as vendors often use it to seek financing for a project that they have successfully tendered for. However, buyers should resist putting the contract price in the LOI as in RTS v Müller, the Courts saw this as one of the factors in finding that a contract existed between RTS and Müller. It is sufficient to indicate in the LOI that the tender by the vendor is successful and that the LOI is subject to contract. Any valuation that is to be done may be carried out externally. If it is necessary for the price of the contract to be incorporated into the LOI, the “subject to contract” provisions must clearly express that the LOI is not intended to be part of the main contract.
The above cases provide guidance in relation to the conduct of vendors and customers in the outsourcing of IT services as well as the importance in crafting provisions in IT contracts to avoid the pitfalls highlighted above. From a legal risk perspective, they serve as a timely reminder to all stakeholders, both IT vendors and IT customers alike, as to the importance of seeking the timely guidance of legal counsel prior to carrying out specific steps or making representations that may adversely affect the stakeholder’s legal standing.
Rajesh Sreenivasan
Shamila Nathan
Rajah & Tann LLP
E-mail: [email protected]